Investors are buying record amounts of insurance contracts to protect themselves from a selloff that has already ended trillions of dollars US stock price.
Buying of options contracts on stocks and exchange-traded funds rose, with big managers spending $34.3 billion on options in the four weeks to Sept. 23, according to data from Options Clearing Corp. analyzed by Sundial Capital Research. The total was the largest on record for 2009 and four times the average since the start of 2020.
Last week alone, institutional investors spent $9.6 billion. The splurge underscores the extent to which big funds want to hedge against a nine-month sell-off that has been fueled by central banks around the world aggressively raising interest rates to tame high inflation.
“Investors understood this [US] “The Federal Reserve’s policy is very limited with inflation where it is, and they can no longer rely on it to manage the risk of asset price volatility, so they need to take more direct action on their own,” said Dave Jilek, chief investment strategist. Gateway Investment Advisors. .
Jason Goepfert, who directs research at Sundial, noted that, adjusted for the growth of the US stock market, the volume of put option purchases over the past two decades has been roughly equivalent to the level reached during the financial crisis. In contrast, demand for call options, which can pay off if stocks rise, has declined.
While the selloff has wiped out more than 22 percent of the benchmark S&P 500 stock index this year — pushing it into a bear market — the decline has been relatively contained and lasted months, not weeks. That disappointed many investors who had hedged with put contracts or bet on a spike in the Cboe Vix volatility index, only to find that the hedge did not act as the intended shock absorber.
Earlier this month The S&P 500 suffered its biggest selloff in more than two years, but the Vix failed to break 30, a phenomenon that has never been recorded before, according to Greg Bootle, strategist at BNP Paribas. Typically, big draws push the Vix well above that level, he added.
Over the past month, money managers have instead turned to buying put contracts on individual stocks, betting that they can better protect their portfolios if they hedge against big moves in companies like FedEx or Ford, which fell sharply after warnings of profits.
“You saw this extraordinary dislocation. It’s very rare that you see this kind of dynamic where individual stock put premiums are so much relative to the index,” said Brian Bost, co-head of Americas equity derivatives at Barclays. “It’s a big structural shift that doesn’t happen every day.”
Investors and strategists say the slow decline in the major indexes was partly caused by investors largely hedging themselves after the slide earlier this year. Long and short equity hedge funds also largely cut their bets after a dismal start to the year, meaning many didn’t have to liquidate large positions.
As stocks fell again on Friday, with more than 2,600 companies hitting fresh 52-week lows this week, Cantor Fitzgerald said its clients were locking in hedging profits and setting new trades at lower strike prices by taking out new insurance.
Wall Street strategists cut year-end forecasts amid tighter Fed policy and a slowdown in economic growth that they warned would soon begin to eat away at corporate profits. Goldman Sachs cut its forecast for the S&P 500 on Friday, expecting further declines in the benchmark as it abandoned its bet on a year-end rally.
“Inflation, economic growth, interest rates, earnings and valuations are changing more than usual,” said David Kostin, a Goldman strategist. “Based on our discussions with clients, most equity investors have taken the view that a hard landing scenario is inevitable.”
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